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Tuesday, March 27, 2012

12 Dividend Stocks For A Powerful Income Stream

Are you looking for companies that can sustain and grow their dividend? In making that determination, a company's Statement of Earnings is one of the last places you should look. Cash is king for the dividend investor and the Statement of Cash Flows is where astute investors begin when they want to understand the viability of a company.
It's not that most companies have done anything wrong when preparing their Statement of Earnings, but under Generally Accepted Accounting Principles (GAAP) a lot of the entries have nothing to do with today's operations. Given this, I generally avoid most earnings related metrics (e.g. EBIT, EBITDA, payout ratio, etc.)

The cash flow statement is not based on accrual accounting, but instead is a cash-basis report focusing on inflows and outflows of cash. It adjusts for transactions that do not directly affect cash receipts and payments, such as adding depreciation back to net earnings. The cash flow statement allows investors to understand how a company's operations are running, where the cash is coming from and how it is being spent.

As an investor in dividend growth stocks, I want to know if a company is financially capable of paying me a higher dividend each year. That's why I focus on cash-based metrics such as these:

Free Cash Flow

This has many definitions, but the one I use is operating cash flow less capital expenditures. Capital expenditures are deducted since you can't run a business for any period of time without expending some level of capital. These two numbers are easily located on the Statement of Cash Flows. This is the best snapshot of what cash the business has generated from "normal" operations and is available for dividends, debt, acquisitions and purchases of treasury stock.

Cash Flow Per Diluted Share

GAAP Earnings Per Share (EPS) has the same short-comings as GAAP earnings. When looking at EPS numbers I prefer a cash-based number. Cash Flow Per Diluted Share is calculated by taking the Free Cash Flow from above and dividing it by diluted shares outstanding (available on the Statement of Earnings).

Cash Payout Ratio

Dividend investors love payout ratios (dividends per share divided by EPS). Given my concerns with GAAP earnings and EPS, I once again prefer a cash-based version. The Cash Payout Ratio is calculated by dividing dividends per share by Cash Flow Per Diluted Share. Care should be taken when interpreting this ratio. For example, sometimes a high ratio with low debt is better than a low ratio with high debt.

Cash Return on Capital Employed

This is simply Free Cash Flow divided by Total Capital (debt + equity). Again, I prefer using a cash number in the numerator. A lot of investors look at return on assets and return on equity. Each are flawed beyond their GAAP numerator. Return on assets ignores the liabilities side of the balance sheet, while return on equity ignores the debt component of capital.

You can fake earnings, but you can't fake cash.

This week, I screened my dividend growth stocks database for select non-financial dividend stocks that have a free cash flow payout of 50% or less with a yield of 3.0% or more. The results are presented below:

Intel Corporation (INTC) is the world's largest manufacturer of microprocessors, the central processing units of PCs, and also produces other semiconductor products.
Yield: 3.0% | FCF Payout: 42.4%

Abbott Laboratories (ABT) is a diversified life science company that is planning to split into two publicly traded companies, one in diversified medical products and the other in research-based pharmaceuticals.
Yield: 3.4% | FCF Payout: 36.6%

ConocoPhillips Co. (COP), formed via the 2002 merger of Phillips Petroleum and Conoco, is the fourth largest integrated oil company in the world, and second largest in the U.S.
Yield: 3.5% | FCF Payout: 28.9%

Lockheed Martin Corp. (LMT) is the world's largest military weapons manufacturer, and is also a significant supplier to NASA and other non-defense government agencies. LMT receives about 93% of its revenues from global defense sales.
Yield: 4.5% | FCF Payout: 46.9%

Verizon Communications (VZ) Inc. offers wireline, wireless and broadband services primarily in the northeastern United States. It acquired MCI in 2006 and has since sold or spun off non-core assets. Alltel was acquired in early 2009.
Yield: 5.1% | FCF Payout: 44.4%

As with past screens, the data presented above is in its raw form. Some of the the companies would be disqualified for poor business fundamentals. However some of the others may be worth additional due diligence.

My database, D4L-Data, is an Open Office spreadsheet containing more than 20 columns of information on the 210+ companies that I track. The data is sortable and has built-in buttons and macros to make it easy to use. Companies included in the list are those that have had a history of dividend growth. The D4L-Data spreadsheet is a part of D4L-Premium Services and is updated each Saturday for subscribers.

Full Disclosure: Long INTC, CVX, EMR, ABT, COP, JNJ, LMT, in my Dividend Growth Portfolio and long MDP VZ in my High-Yield portfolio. See a list of all my dividend growth holdings here.

2 comments:

Anon: As noted in the article, FCF Payout "is calculated by dividing dividends per share by Cash Flow Per Diluted Share." It is important because dividends are paid out of free cash flow which is different from GAAP earnings.

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